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There is a special treatment for such payments - see this publication - http://www.irs.gov/pub/irs-pdf/p525.pdf page 34:
Holocaust victims restitution. Restitution payments you receive as a Holocaust victim (or the heir of a Holocaust victim) and interest earned on the payments are not taxable. Excludable interest is earned by escrow accounts or settlement funds established for holding funds prior to the settlement. You also do not include the restitution payments and interest the funds earned prior to disbursement in any computations in which you ordinarily would add excludable income to your adjusted gross income, such as the computation to determine the taxable part of social security benefits. If the payments are made in property, your basis in the property is its fair market value when you receive it.
Excludable restitution payments are payments or distributions made by any country or any other entity because of persecution of an individual on the basis of race, religion, physical or mental disability, or sexual orientation by Nazi Germany, any other Axis regime, or any other Nazi-controlled or Nazi-allied country, whether the payments are made under a law or as a result of a legal action. They include compensation or reparation for property losses resulting from Nazi persecution, including proceeds under insurance policies issued before and during World War II by European insurance companies.
If that is your case - such payments are not taxable.